Herbal remedies

The first mini-bull market of the century, and not much to show for it

WHEN the Sage of Omaha talks, his investors listen, although they don't always like what they hear. The most striking feature of the mea culpa sent by Warren Buffett, Berkshire Hathaway's chairman, to the diversified investment company's shareholders on March 5th was not his apology for failing to produce returns commensurate with those on the S&P 500 stockmarket index. It was his wistful admission that he is having trouble finding any company worth investing in.

In that, he is not alone. Most companies do not even want to invest in themselves these days, and instead are returning cash to shareholders by the shovelful. In 2004, estimates J.P. Morgan, companies in the S&P 500 index paid $181 billion in cash dividends and spent $150 billion on share buybacks, handing a record sum back to their owners. There are many reasons for this phenomenon, including changes in dividend taxation in America and huge corporate profits in most places. But one thing is clear: companies do not think they can earn much by retaining earnings. So it is better to hand the money back, or buy other firms.

Take another highly successful investment firm in a slightly different line of business: Steven Tananbaum's GoldenTree Asset Management, with $7 billion of assets under management, mainly held in bonds. Since investment firms survive by collecting fees for managing their clients' money, a decision to give that money back catches the eye. On March 7th GoldenTree said that it would return $1.2 billion to investors. In essence, this is the money GoldenTree restricted to investment in the high-yield debt market.

Mr Tananbaum is something of a contrarian. When he opened GoldenTree in March 2000, stockmarkets were at their peak, so a new fund devoted to bonds, even one run by a manager with a fine track record, seemed barely worth noticing. Since then, times have changed. The NASDAQ share index, full of tech stocks, is still at less than half its peak; even the broader S&P 500 has yet to regain its former level. Day-trading in shares, which five years ago was seen as a profession, is now recalled as an affliction. Yet the bond market has been on a mild bull run.

Not only did Mr Tananbaum pick the right market, he also outperformed it handsomely. GoldenTree's hedge funds have returned 14% a year after fees, against 8% on the average fixed-income mutual fund, and with little volatility. In the world of money managers, he is a star—perhaps even a new sage. He could easily raise more money, but has chosen to contract. “It is”, says Mr Tananbaum, “a cyclical call on the market.” Overall rates will rise, and the spread between risky and non-risky bonds will widen. So he is looking at shorting bonds and buying the shares of junk-bond issuers (not their bonds) and other oddities. As a mere buyer and holder of bonds, he says, he has ceased to add value.

That will sound familiar to Mr Buffett, who agonises in print that unless he can outdo the S&P 500 he is adding nothing to what investors can achieve on their own. True enough. In 2004, Berkshire increased its per-share book value (which it prefers to earnings per share as a measure of performance) by 10.5%; the S&P index rose by 10.9%, dividends included. Net profits actually fell, by 10%, to $7.3 billion. In 2003, Berkshire also failed to match the S&P 500, increasing per-share book value by 21% against the S&P's 28.7%. Over time, however the company has beaten the index by two to one.

Berkshire has not been lucky with General Re, an insurer it bought in 1998, which made only $3m in underwriting profit. Mr Buffett praises its newish chief executive but refers darkly to “adverse developments from the years before he took the helm”. It is unclear whether these are responsible for adverse developments today: namely, Berkshire's co-operation with the investigation by Eliot Spitzer, New York's attorney-general, and the Securities and Exchange Commission of “loss-mitigation” insurance products, which they think companies may be using improperly to smooth financial results. Both Mr Buffett and Hank Greenberg, chief executive of American International Group, the world's biggest insurer, have received subpoenas.

But the real culprit for Berkshire's underperformance was cash: the $43 billion that Mr Buffett had hoped would pay for several acquisitions, had he only been able to find something. Instead, it sat inert on the balance sheet, dragging down returns. Now he and Charlie Munger, his sidekick and vice-chairman, would like “a little action”, he says. The problem is that all the other companies loaded with cash are looking for just the same.